Chapter-2

ENERGY ECONOMIC ANALYSIS

Introduction:

E ngineering Economy is a collection of mathematical techniques that simplify

economic comparisons. Engineering Economy involves formulating,
estimating, and evaluating the economic outcomes when alternatives to
accomplish a defined purpose are available. Engineers are called upon to analyze and
select the most economical alternative among several design alternatives. Engineers often
play a major role in investment decisions based on the analysis and design of new
products or processes.
Energy exists in various forms across the globe, for human comforts. it has to be
transformed into a convenient (Electrical) form and made available at the door steps of
the cosumer.for this huge sum of money (in corers) has to be spent /invested by
government /public sectors on the energy projects/programmes. If the investment is not
judicious, then the entrepreneurs (company) suffer huge losses. Hence to justify the
energy investment cost, knowledge of life cycle costing is required.

2.1.The time value of money concept:

“The change in the amount of money over a given time period is called the time value
of money” Money can “make” money if invested. Money made depends on the interest
rate Money has a time value. capital can be employed productively to generate positive
returns, in which case an investment of one rupee today would grow to (1+r) in a year
where r is the rate of return earned on the investment. But in an inflationary period, a
rupee today represents a greater purchasing power than a rupee a year hence. Almost

34
 35 Energy Auditing and Demand side Management

every one is directly exposed to interest transactions and is indirectly affected regularly.
It is essential to know the various factors and qualities. Which have to be considered in
the various types of costs like money to be spent, money to be borrowed, money to be
kept as depreciation etc, the knowledge involved in the calculation of interest, annuities
etc ,helps to formulate the budget. It also helps to take a decision regarding the selection
of proper equipment from various available alternatives.
The cash flow occurs at different points of time have to be brought to the same point of
time for purposes of comparision.hence,it is important to understand the role of
compounding and discounting in dealing with the time value of money.
2.2. Interest:
Interest is the earning power of money. It represents the growth of capital per
unit period. The period may be a month, a qurter, semi annual or a year. In other words,
interest is the income produced by money that is lent or loaned. it is the premium paid to
compensate a lender for the administrative expenses for making a loan for risk of non
payment and loss of use of the loaned money.
Types of interest:

2.3.
2.3.1. Simple interest:
In simple interest, the interest to pay on repayment of loan is proportional to the length of
the time and the principle sum borrowed. Let P=principal amount
i=Rate of interest
n=no of periods
Then ,Total interest, i=Pni
If F is the total sum realized after n years, then
F=P+i=P+Pni
F=P (1+ni)
2.3.2. Compound interest:
In compound interest, the interest for the current period is computed based the amount
i.e., principal plus interest up to the end of the previous period .At the beginning of the
current period. It means that each interest payment is re invested to earn further interest
in future periods.
Let P=Principal amount at the beginning of the year
F=Future amount
R=Rate of interest per annum
At the end of 1st year, the amount payable, F1=P (1+i)
At the end of 2nd year, the amount payable, F2=P (1+i) + (1+i)
F2=P (1+i) 2
F3= P (1+i) 3
Chapter 2 Energy Economic Analysis 36

Generally at the end of ‘n’ years, Total amount accumulated will be Fn=P (1+i) n
2.3.3. Nominal interest rate:
Ihe interest period is normally one year. The interest based annually is known as nominal
Interest rate effective interest rate
2.3.4. Effective interest:
Sometimes, the interest period may be less than one year. In half yearly compounding,
interest is compounded twice a year, in quarterly four times a year and in monthly 12
times a year and so on, based on the number of compounding periods, this frequent
compounding results in higher interest rates. This interest rate is known as effective
interest rate.
If i=nominal interest rate, C= no of compounding in a year, ie= Effective interest rate

( C)
C
i
Then, ie= 1+ −1

Note:
When compounding is more than once a year, then Future amount can be found either by
(1) Finding out the effective interest rate (ie) and then substituting the effective rate in
F=P (1+ie) n, or
By using the formula F= P 1+ ( )
i cn
C
Where i= Nominal rate of interest, C=No of interest periods/year, n=total no of years
2.3.5. True or continoues compounding:
the ultimate limit for the no of compounding periods in one year is called continuous
compounding. The effective interest for continuous compounding for a nominal interest
rate (i) is developed as
i e=ei-1 and F=Pe n i e
2.3.6. Present worth:
Refers to the value of money as on dated for which payment has to be made at a future
day with due interest
2.3.7. Future worth:
Refers to the realized amount along with interest
Annuity:
It is a sum of money received or paid in annual in one or more instalments, for a given
period of time. Is a stream of constant flow, either payment receipt occurring at a regular
interval of time.
37 Energy Auditing and Demand side Management

2.4 Developing cash flow models:

2.4.1. Cash flow diagram:
It is a tool in graphical form which helps the decision maker to understand and solve
problem during several equivalent situations. During the construction of a cash flow
diagram, the structure of a problem often becomes distinct. it is usual advantageous to
first define the time frame over which cash flow occurs. This establishes the horizontal
scale; it is divided into time period, often in years. Cash flow are then located on the time
scale in adherence to problem specifications.

2.4.2.The cash flow model: The cash flow model assumes that cash flow
occurs at discrete points in terms of lump sum and that interest is computed and payable
at discrete points in time. To develop cash flow model which illustrates the effect of
compounding of interest payments, the cash flow model is developed as follows:
End of year 1: p+i (p) = (1+i) P
End of year 2: (1+i) P+ (1+i) Pi= (1+i) P (1+i) = (1+i) 2p
End of year 3= (1+i) 3p
Year n: (1+i) n P or S= (1+i) n P
Where p= present sum
i= Interest rate earned at the end of each interest period
n= number of interest periods
s= future value

(1+i) n P is refereed as the single payment compound amount factor and is tabulated for
various values of i
The cash flow model can also be used to find the present value of a future sum S

P=
( 1
)
( 1+ i)n
S

Cash flow models can be developed for a variety of other types of each as illustrated in
figure below
Chapter 2 Energy Economic Analysis 38

Where R is a Uniform series of year end payments and s is the future sum of R payments
for n interest periods.
The R dollars deposited at the end of the n th period earns no interest and there fore
contribute R dollars to the fund .The R dollars deposited at the end of the (n-1) period
earn interest for 1 tear and will there fore, contribute R (1+i) dollars to the fund. The R
Dollars deposited at the end of (n-1) period earn interest for 1 year and there fore
contribute R (n+1) Dollars to the fund.
R Dollars deposited at the end of (n-2) period earn interest for 2 years and will ,therefore,
contribute R (1+i)2 these years of earned interest in the contribution will continue to
increase in this manner. And the R deposited at the end of the first period will have
earned interest for (n-1) periods. The total in the sum S is, thus equal to

R+R(1+i)+R(1+i)2+ R(1+i)3+ R(1+i)4+….. + R (1+i) n-2+ R (1+i) n-1.

Factorizing out R.

S=R[1+(1+i)+ (1+i)2+…….+(1+i) n-2+(1+i) n-1]----------------(1)

Multiplying both sides of this equation by (1+i)

(1+i)S= R[(1+i)+ (1+i)2+…….+(1+i) n-1+(1+i) n]----------------(2)

Subtracting equation 1 from equation 2

(1+i)S-S= R[(1+i)+ (1+i)2+…….+(1+i) n-1+(1+i) n]- R[1+(1+i)+ (1+i)2+….+(1+i) n-2(1+i) n-1]

Si=R [(1+i) n-1]

( R[(1+i) n−1])
S¿ i
-------------------- (3)

The equation 3 is the cash flow model for the present value of a future sum S
Interest factors are seldom calculated. They can determine from programs, each factor is
defined when number of periods (n) and interest rate (i) is specified. In the case of
39 Energy Auditing and Demand side Management
Chapter 2 Energy Economic Analysis 40

Gradient present worth factor the escalation rate must also be stated. The three most
commonly used methods in life cycle costing are the annual cost, present worth and rate
of return analysis.
Single payment compound amount –
SPCA
The SPCA factor is the future value of one
dollar in “n”periods at interest of
“i”present. S=PX (SPCA)ni Formula
—(2.1)

Single payment present worth –SPPW

Then SPPW factor is the present of one
dollar. “n”perids from now at interest of
“I”Present. SPCA=(1+i)n
P=SX(SPPW)in Formula—(2.2) 1
SPPW =
¿¿

Uniform series compound amount-

USCA
The USCA factor is the future value of a
uniform series of 1 dollar deposits.
S=Rx(USCA)in Formula—(2.3)

Sinking fund payment –SFP

SFP factor is the uniform series of deposits USCA=¿ ¿
whose future value is one dollar. i
SFP=
R=Sx(SFP)in Formula—(2.4) ¿¿

Uniform series present worth-USPW

The USPW factor is the present value of
uniform series of one dollar deposits.
P=Rx(USPW)in Formula—(2.5)

Capital recovery-CR
The CR factor is the uniform series of
deposits whose present value is one dollar.
R=Px(CR)in Formula-(2.6) (1+i )n −1
USPW = n
i (1+i )
41 Energy Auditing and Demand side Management

i (1+i)n
CR=
( 1+i )n−1

Gradient present worth-GPW

The GPW factor is the present value of a
gradient series
P=Rx(GPW)in Formula-(2.7)

NOTES
WHERE
P= is the present worth (occurs at the beginning of the interest period).
S== is the future worth (occurs at the end).
n== is the number of periods that the interest is compounded.
i== is the interest rate or desired rate of rate of return.
R== is the uniform series of deposits (occurs at the end of the interest period).
e== is the escalation rate.

2.5 Pay back analysis:

The simple payback analysis is sometimes used instead of the methods previously out
lined the simple pay back is defined as an investment divided by annual savings after
taxes. The simple pay back does not take into account the effect of interest or escalation
rate. Since the pay back period is relatively simple to calculate and due to the fact
managers wish to recover their investment as rapidly as possible the payback method is
frequently used. It should be used in conjunction with other decision tools. when used by
itself as the principal criterion it may result in choosing less profitable investments which
yield high initial returns for short period as compared with more profitable investments
which provide profits over long period of time The pay back period is based upon
determining the numbers of years required for the invested capital to be recovered from
net cash flows.

Net investment∨capital cost

Pay period=
Net annual cash flow∨net annual savungs
Chapter 2 Energy Economic Analysis 42

In order to compare two or more alternatives .some maximum acceptable time horizon N
is estimated by which if benefit cash flows do not cover all cost flows in the period.
43 Energy Auditing and Demand side Management

The project is rejected, i.e. accept it if

n

∑ CFi−Cost > 0
i=0
Where CFi=cash flows, cost=cost, t=time
Computationally the method is simple, how ever, conceptually. it has the
following

Disadvantages and Advantages

Disadvantages:
1. The time value of money is not directly considered, indeed payback implies a zero
discount rate toN and an infinite rate there after. With no pinning down of the particular
time of money. One can only compare alternative conservation actions that require
exactly the same life or term and cannot compare optional programmes that would have
different estimated life time periods
2. The effect of cash flows occurring after the payback period is not considered. Clearly,
the method makes no allowance for projects with long gestation periods, the selection of
N being arbitrary.
Advantages:
1.A rapid pay back may be a prime criterion for judging on investment when financial
resource are available to the investor for only a short period of time.
2. The speculative investor who has a very limited time horizon will usually desire rapid
recovery of the initial investment.
3. Where the expected life of the assets is highly uncertain, the determination of the
breakeven life, i.e, pay back period, is helpful in assessing the likelihood of achieving a
successful investment.

2.6. Depreciation
Depreciation can be defined as “a falling off value of an article or machine”. When
applied to money it means a loss of exchange value or purchasing power applied to other
things it means a lowering of other things. It is also defined as “fall in the capital outlay
of wasting assets” Depreciation is the accounting of the deterioration of the physical and
functional utility of a fixed asset due to usage and time. . Internal Revenue Service allows
several methods for determining the annual depreciation rate. Depreciation affects the
accounting procedure for determining profits and losses and the income tax of a
company. In other words for tax purposes the expenditure for on asset such as a pump or
motor cannot be fully expensed in its first year. The original investment must be charged
Chapter 2 Energy Economic Analysis 44

of for tax purposes over the useful life of the asset .company usually wishes to expense
an item as quickly as possible.

2.7 Methods of depreciation:

1. Straight line depreciation.
2. Sum of years digits depreciation.
3. Declining balance depreciation.
4. Sinking fund depreciation.

2.7.1 Straight line depreciation:

the useful life of any plant may be fixed by the time taken for it to wear out and become
unfit for further use, or it may be fixed by becoming obsolete due to new technical
improvements .in either case, money must be set aside, so that at the end of the useful life
of the plant there will be a sufficient sum available to purchase a new plant, to carry on
the business, or to repay the loan which was initially raised to purchase the plant. The PP
calculated above, illustrating just how long it will take for an investment to be paid off
through operating savings, does not differentiate between money saved now and money
saved in the future,i.e there is no recognition of the time value of money. With no pinning
down of the particular time values of money, one must only compare alternative
conservation actions that require exactly the same life or term. and one cannot compare
optional programmed that have different estimated life time periods .The simplest
method is referred to as straight line depreciation and is

(P−L)
D=
n

Stright line annual depreciation=Initial cost−Salvage value¿ ¿

Number of yearsof useful lif

Where; D is the annual Depreciation rate; L is the value of equipment at the end of its
useful life, commonly referred to as Salvage value; n is the Number of years of useful life
of equipment which is determined by internal revenue Service Guidelines; P is the initial
cost. The figure 2.7.1 illustrates the straight line depreciation Method
45 Energy Auditing and Demand side Management

Fig.2.7.1.Stright line Depreciation

2.7.2 Sum of years digits depreciation

Another method is referred to as the sum of year digits .in this method the depreciation
rate is determined by finding the sum of digits using the following formula:
n(n+1)
N= Formula
2
Where n is the life of equipment.each year’s depreciation rate is determined as follows:

n
First year D= Formula
N (P−L)

n−1
Second year D= Formula
N (P−L)
1
nth year D= Formula
N (P−L)

2.7.3. Declining balance depreciation

The declining balance method allows for larger depreciation charges in the early years
which are some times referred to as fast write-off. (Fixed percentage method) The rate is
calculated by taking a constant percentage of the declining undepreciated balance. The
most common method used to calculate the declining balance is to pre determines the
depreciation rate. Under certain circumstances a rate equal to 200% of the straight line
depreciation rate may be used. Under other circumstances the rate is limited to 1 ½ or ¼
times as great as straight line depreciation. In this method the salvage value or
undepreciated book value is established once the depreciated rate is reestablished.
Chapter 2 Energy Economic Analysis 46
47 Energy Auditing and Demand side Management

To calculate the undepreciated book value below formula is used

D=1−¿ Formula

Where
D is the annual depreciation rate
L is the salvage value
P is the first cost.

2.7.4 Sinking Fund Depreciation method:

It may be necessary to take a loan from a bank to purchase new equipment .this loan must
be repaid over the life time of the equipment. the usual method of ensuring loan
repayment is to pay annual installments into a deposit called “sinking fund”.This method
is based on the fact that the annual depreciation reserve, when invested at compound
interest, will accumulate to the difference between the initial cost and the salvage value at
the end of the usefull life of the equipment.

i
Annual sinking fund Depreciation reserve ¿ [Initial cost −Salvage value] X ⌈ ⌉
( 1+i ¿¿¿ n )−1
Where i is the interest rate and n is the number of years.The sinking fund Dpreciation
method is illustrated in Fig 2.7.4

Fig 2.7.4.Sinking fund depreciation

Chapter 2 Energy Economic Analysis 48

2.8 Taxes and tax credit

2.8.1 Tax Consideration

Tax deductible expenses such as maintenance, energy, operating costs, insurance and
property taxes reduce the income subject to taxes. For the after tax life cycle cost analysis
and payback analysis the actual incurred annual savings is given as follows:
AS= (1-i) E+iD
AS= yearly annual after tax savings (excluding effect of tax credit)
E=yearly annual energy savings (difference between original expenses and expenses
After modification)
D=annual depreciation rate
i=income tax bracket
2.8.2 Tax Credit
A tax credit encourages capital investment. Essentially the tax credit lowers the income
tax paid by the tax credit to an upper limit. In addition to the investment cost credit, the
Business Energy Tax Credit as a National Energy Plan can also be taken. The tax credit
substantially increases the investment merit of the investment, since it lowers the bottom
line on the tax form.

2.9 Economic Decision-Making Process

Collect relevant information regarding the project

1. Initial Costs: Design, Manufacturing, Marketing, Testing, Installation,

Construction, Taxes, down payments, etc.
2. Annual Costs: Operating, Maintenance, Finance Payments, Insurance, Income
Taxes,
3. Periodic Costs: Overhauls, Improvements and Modifications.
4. Annual Receipts: Income generated and Savings due to increased Productivity.
5. Salvage Value: Income generated by sale or cost to remove obsolete equipment.

2.10 Recognize and Define Feasible Alternatives:

Consider all possible options including the “Do nothing” alternative. The generated
alternatives may not be economically viable. Examine each alternative and remove any
overlapping options. If the productivity is the about the same for each alternative, focus
only on the costs
 49 Energy Auditing and Demand side Management

2.11 Life Cycle Cost Analysis:

The life cycle cost analysis evaluates the total owning and operating cost. It takes into
account the time value of money and can incorporate fuel cost escalation into the
economic model. This approach also used to evaluate competitive projects. In other
words the life cycle cost analysis considers the cost over the life of system rather than the
just the initial investment cost. Such an analysis of money spent on energy projects is the
energy economic analysis.
Typical costs for a system may include:
 Design and development costs.
 Operating costs
 Cost of repair
 Cost of failure
 Down time cost
 Cost of spares
 Loss of production 1) Disposal cost 2) Other costs
 Accounting financial elements ,such as discount rates, interest rates, depreciation
 Present value of money

2.12 Different Ways to Minimize Costs

1. Project Engineering wants to minimize capital costs as the y criteria,
2. Maintenance Engineering wants to minimize repair hours as the only criteria,
3. Production wants to maximize uptime hours as the only criteria,
4. Reliability Engineering wants to avoid failures as the only criteria,
5. Accounting wants to maximize project net present value as the only criteria, and
6. Shareholders want to increase stockholder wealth as the only criteria.
7. Management is responsible for harmonizing these potential conflicts under the
banner of operating for the lowest long term cost of ownership.
8. LCC can be used as a management decision tool for harmonizing the never
ending conflicts by focusing on f acts, money, and time.

2.13 Worked Ecamples

2.13 .1 Mr. x deposit’s Rs. 2000 in a SB account which pays an interest rate of 8% per
year
compounded annually. If all the money is accumulated, how much will Mr. x will
have after
Ans: - P = Rs. 2000 F=?
I = 8% compounded annually i = 8%
N = 10 years n = 10 years
F = P (1+i) n = 2000 (1+0.08)10
Chapter 2 Energy Economic Analysis 50

F = Rs. 4317.85 P=2000

2.13 .2 How much money must be deposited in a SB account so that Rs. 2, 00,000 can
be withdrawn after 12 years from now, if the interest rte is 9% compounded annually?

Ans:- F = Rs. 2,00,000

n = 12 years
i = 9% compounded annually
P = P(1+i)n = 2000 (1+0.08)10 P= ?

F 200000 200000
P= = =
n
( 1+i ) ( 1+0.09 )12
2.8127

P = Rs. 71106.945
2.13 .3 A person invests a sum of Rs. 5000 in a bank at a nominal interest rate of 12%
for 10 years the compounding is quarterly. Find the maturity value of the deposit after 10
years?
Ans:-
P = Rs. 5000
n = 10 years
i = 12% (nominal)
F=?
C = No. of compounding F = Rs. 16310.19
=4 in a year
2.13 .4 A company wants to set up a reserve which wills the company to have an
annual equivalent amount of Rs. 10, 00,000 for the next years towards its employee’s
welfare measures. The reserve is assumed to grow at the rate of 15% annually. Find the
single – payment that will be made now as the reserve amount.
Ans:- A = Rs. 10,00,000
I = 15%
n = 20 years
P =?

P = Rs. 62, 59,300.

51 Energy Auditing and Demand side Management

2.13 .5 A person who is now 35 years old is planning for hi, retired life. He plans to
invest an equal sum of Rs. 10,000 at the end of every year for the next 25 years starting
from the end of the next year. The bank gives 20% interest rate, compounded annually.
Find the maturity value, his account when he is 60 years old.
Ans:- A = Rs. 10,000
n = 25years ir. (60-35)
i = 20%
F =?

F = Rs. 47, 19,810

2.13.6. An industry has to replace a present facility after 15 years at an outlay of Rs.
500000. It plans to deposit an equal amount at the end of every year for the next 15 years
at an interest rate of 18% compounded annually. Find the equivalent amount that must be
deposited at the end of every year for the next 15 years.
Ans: - F = Rs. 500000
n = 15years
i = 18% compounded annually
A =?

A = Rs. 8,200.

2.13 .7 Mr. X deposits Rs. 1000 at the end of each year which pays an interest rate of
6% compounded annually. How long does it take to accumulate Rs. 20000?
Ans:- A = Rs. 1000
i = 6%
F = Rs. 20,000
n =?
Chapter 2 Energy Economic Analysis 52

20000
( 1.06 )n −1= x 0.06=1.20
1000
( 1.06 )n =1.2+1=2.2
Taking log on both sides
n log 1.06 = log 2.2
log 2.2 0.342 4
n= = =13.53Years
log 1.06 0 .0253
n = 13 years 6 months 11 days.

2.13 .8 A father wants to set aside his money for his 5 year old son for future
education. Money can be deposited in a bank account that pays 8% per year compounded
annually. What deposits should be made by the father till his son’s 17 th birthday in order
to provide his son Rs. 5000 on his 18th, 19th, 20th & 21th birthday?

Ans:-

StepI A= 5000
P= A
[
( 1+i )n−1
i ( 1+i )
n
] [
=5000
( 1+0.08 ) 4−1
0.08 ( 1+0.08 )
4
]
I = 8%
n = 4 years
P =?
=Rs 16560/-
53 Energy Auditing and Demand side Management

Step II
F= Rs. 16560 (ie. Pobtained before)
I = 8%]
n = 12years (from 5th to 17th year)
A=?

A=F
[ i
]
n
( 1+ i) −1
=16560
[ 0.08
12
]
(1+ 0.08 ) −1
=16560 x
0.01
1.51
A = Rs. 872.63

2.13 .9 A TV set can be purchased for a down cash of Rs. 5060. Alternatively it can be
purchased for an initial payment of Rs. 750 only, with another 24 end monthly
installment. By how much will the total exceed the cash price, if the interest if reckoned
at 1% p.m?

Ans:- case I For down cash payment, P1 = Rs. 5000

Case II For installment payment,

[
P2 = Rs. 750 + 24 months x
monthly instalment amount
for the balance amount ]
We have,
Balance amount = Rs. 5000 – Rs. 750
Chapter 2 Energy Economic Analysis 54

Monthly installment amount of balance amount

[ ] [ ]
24 n
0.01 ( 1+ 0.01 ) i ( 1+i )
¿ 4250 A=P
( 1+0.01 )24−1 ( 1+i )n−1

= 4250 X [ 0.01(1.2697)
1.2697−1
= 4250 x ]
0.012697
0.2697
= Rs. 200.08
 Net amount paid P2 = 750 + (24x200.08)
= Rs. 5551.92
 The total exceeds the cash price by
(Rs. 5551.92 – Rs. 5000) = Rs. 551.92.

2.13 .10 A person arranges to pay Rs. 1000 loan in 10 annual installments. The
rate of interest is 10%. After paying 5th installment, he wishes to pay the balance in a
lump sum at the end. How much has he to pay assuming there is no penalty amount?

Ans: - For n = 10 year

i = 10%
P = 1000

We find A,

[ ]
n
i ( 1+i )
A=P
( 1+i )n−1

[ ] [ ]
10
0.1 ( 1.1 ) 0.2594
A=1000 =1000 =1000( 0.16275)
(1.1 ) −1 10
1.5937

A = Rs. 162.75
The person pays such five installments in the beginning i.e., Rs. 162.75x5 = Rs. 813.75.
And the remaining loan amount is paid at the end of 10 years. So, For A= Rs. 162.75, n =
5, i = 10%
We find P

P= A
[( 1+i )n−1
i ( 1+i )
n
]
=162.75
[
( 1+0.1 )5−1
0.1 ( 1.1 )
5
]
55 Energy Auditing and Demand side Management

0.6105
= 162.75 x = Rs. 616.95
0.16105

For this , P = Rs. 616.75, n = 5years, i = 10%,

We find Fi.e., F=P ( 1+i )n
= 616.75 (1+0.1)5
F = Rs. 993.604 is the balance amount paid in lump sum.

2.13 .11 How long will it take for a sum of money to double? When a accumulating at
5% interest?

a) On simple interest basis

b) If interest is compounded annually
c) If interest is compounded quarterly and
d) If interest is compounded on true compound interest basis
Ans: Let P = Present sum of money to be deposited
F = Future worth of money = 2xP = 2P
n = No. of years which is to be found
i = 0.05 (rate of interest)
c = No. of compounding in a year
(a) F = P + S.I + P + Pni
i.e., 2P = P (1+in) = P(1+0.05n)
1+0.05n = 2
2−1 1
n= = =20 years
0.057 0.05

(b) F = P(1+i)n
2P = P(1+0.05)n = 1.05n
Log2 = n log 1.05
log 2 0.301
n= = =19.207 years=14 years2.5 months
log 1.05 0.02119

( ) ¿have c=4]
cn
i
(c) F = P 1+
c
Chapter 2 Energy Economic Analysis 56

( )
4n
0.05
2P = P 1+
4
2 = (1.0125)4n
Log2 = 4n log 1.0125
log 2
n= =13.9494 years = 13years 11.4 months.
4 log 1.0125

(d) F = Peni
2P = Pe0.05n
E0.05n = 2
0.05n = ln2
ln 2
N=
0.05

2.13.12. A person is planning for his retired life. He has ten more years of service. He
would like to deposit 20% of his salary, which is Rs. 4000, at the end of the first year and
there after he wishes to deposit the amount with an annual increase of Rs. 500 for the
next 9 years with an interest rate of 15%. Find the total amount at the end of the 10 th year
of the above series.
Ans: - A1 = Rs. 4000
G = Rs. 500
i = 15%
n = 10 years
A =?
F =?
We have,
1
A = A1 + G i − [ n
( 1+ i )n−1 ]
1
= 4000+500 0.15 − [ 10
( 1+0.15 )10−1 ]
= 4000+500 [ 1
−
10
0.15 3.0456 ]
=4000+5000
[
3.0456−10 x 0.15
0.15 x 3.0456 ]
1.5456
[
= 4000+500 0.4568 =4000+1691.62 ]
57 Energy Auditing and Demand side Management

A = 5691.62

We have F = A [ i ]
( 1+ i )n −1
=5691.62 A [
( 1+0.15 )10−1
0.15 ]
= 5691.62 x
3.0456
0.15
The total amount at the end of 10th year F = Rs. 115561.05

2.13 .13 Calculate the depreciation rate using the (i) Stright Line,
(ii) Sum -of -year’s digit and Declining- balance methods, for the data given below:
Salvage Value is Rs 0
Life of the equipment, n=5 Years
Initial Expenditure, P=Rs.1, 50,000
For a declining balance method use a 200%rate.
VTU/Dec 2010/08marks

Ans: Stright-Line Method:

P−L 150000
D= ;
D= = Rs 30,000/year
n 5

Sum - of- years digit method:

n(n+1) ; 5(5+1) ;
N= N= N =15
2 2
n 5
D1 = N (P) = 15 (150,000) = Rs 50,000; for n=5, P= Rs50, 000
n 4
D2 = N (P) = 15 (150,000) = Rs 40,000; for n=4, P=Rs 40,000
n 3
D1 = N (P) = 15 (150,000) = Rs 30,000; for n=3, P=Rs 30,000

n 2
D1 = N
(P)
= 15
(150,000) = Rs 20,000; for n=2, P=Rs 20,000

n 1
D1 = N
(P)
= 15
(150,000) = Rs 10,000; for n=1, P=Rs 10,000

Declining- Balance method:

D = 2x20%=40%
Stright Line Depreciation rate=20%,Total depreciation charge=Rs 138,336
Undepreciated book value=P-D=Rs (150,000-138,336) =Rs 11,664
Chapter 2 Energy Economic Analysis 58

2.13 .14.You have accumulated Rs 5000 in credit card debit.The credit card company
charges 18% nominal annual interest compounded monthly.you can only offered to pay
only Rs 100 per month.How many months will it take you to pay-off debit and how much
money will you have to pay as interest?

VTU/Dec.09/Jan.10/08marks

( )
12n
i
1+ −1
P 12
Ans: A = i
12
1+( 12
i 12 n
)
( )
12 n
0.18
[ 1+ −1]
5000 12
100 = 0.18
( )
12n
0.18
[ 1+ ]
12 12
= 0.75(1.015) 12n
- (1.015) 12n +1=0

93.64
n= 12 =8 years

n =8x12=96 months

2.13 .15. The Original Cost of an asset is Rs 8000. It has a salvage value of Rs. 500 at
the end of 8 Years evaluate its book value at the end of 5th year by Reducing -balance
method.

()
1
v L
Ans: Rate of Depreciation r =1−
c
¿ 1−
500 18
8000 ( )
¿ 0.293
¿ 29.3 %
V5 = C (1-r) 5
Assumptions:
1. Cost & repair increase with time = 8000 (1-0.293) 5
2. Depreciation in higher during starting.
3. Depreciation reducing with passage of time V5 = Rs. 1,414.21
4. Realistic method
59 Energy Auditing and Demand side Management

2.13 .16. An industrial plant with value of Rs. 400,000 has a salvage value of Rs. 50,000
at the end of 25 years but sold for Rs. 260,000 at the end of 10 th year. What is the profit
or loss to the owner if sinking fund method of depreciation is adopted the interest at 8%

Ans: C = 400000; Salvage Value = 50000; r = 0.08 (8%)

Accrued depreciation, A = C-V
= Rs (400,000 – 50,000)
= Rs 350,000
The annual sinking fund deposit is given by

D = (C-V)i ; L = 25Years

D = [(400,000-50,000) 0.08] = Rs 4787.60

(1.08) 25-1)
Accrued Depreciation at the end of 10 year is
D L
A10 = ⌈ (1+i) −1⌉ for L=10 Years
i

4787.60
A10 = ⌈ (1+ 0.08)10−1 ⌉
0.08

Rs. 69,356

Expected value at the end of 10th year

V10 = (C –A)

400,000-69,356

V10 = 330,644

But the plant is sold at 260,000

So owner suffers a loss of
Rs. (3 30,644-260,000) = Rs.70, 644

2.13.13. A Manufacturing concern purchases a Lathe for Rs. 9000 the freight and haulage cost
is Rs. 200 and the Charges for installation it is Rs. 250 its life is 20 years and the scrap value is Rs
300. Calculate the annual Depreciation charges by straight line method.
Chapter 2 Energy Economic Analysis 60

Ans: First Cost or Capical Cost

Invoice Cost + Transportation Cost +Installation Charges

Rs. (9000+250+200) = Rs. 9450/-

Salvage Value: 300 Rs. Its life 20 Years

C−V 9450−300
Annual Depreciation = = = Rs 457.5
L 20

2.13.14. The following particulars are available for the purchase of an electrical machine
Initial Cost Rs. 40,000, Transportation Charges Rs 500, Installation Cost Rs 1000, Accessories Rs
2500 Estimated salvage value Rs 5000, estimated life 20 Years, Calculate by straight line method
(a) Amount to be recoverd
(b) Annual depreciation cost
(c) The depreciation book value at the end of 10 years.

Sol: C = First cost of the machine

C = Invoice + Transportation + Installation + Accessories
C = 40,000+500+1000+2500, C = 44,000
V = Salvate value Rs 5000
L = Life of equipment 20 years

a) Amount to be recovered
A = (C - V)
= Rs (44000-5000)
= Rs 39,000

b) Annual depreciation cost

A 39,000
D= = = Rs19500
L 20

A10 = 1950 x 10 = Rs19500

c) Book value after 10 years (44000-19500) = Rs24,500

 61 Energy Auditing and Demand side Management

2.14. QUESTION BANK

1. What is the time value of money concept? What are the different cash flow modules?
2. Explain pay back analysis.Mention its advantages and disadvantages.
3. Write short notes on couses of Depreciation and energy audit instruments.
4. What do you understand by depreciation? Explain how depreciation reserve is
Calculated using using: i) Sum of digits method; ii) Stright line Method.
5. Develop a cash flow model for Uniform series compound amount factor.
6. What is meant by life cycle cost analysis? Develop single payment compound amount
Cashflow model.